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Time is on your side
Last week, we touched on the topic of market timing with the opinion that the amount of time invested in the market has a greater influence on wealth accumulation that trying to time a market low.
Our clients are often hesitant to invest in the market during volatile periods. They ask if they should wait and/or when would be the most opportune time to put money to work. To answer that, would require the ability to see into the future and know precisely when the market will hit bottom. Unfortunately, we do not have that level of foresight (although we are still looking for it). We know we cannot time markets, so we lay out the possible scenarios and probable results of different scenarios.
As previous posts highlight (first, second), investing sooner rather than later is best. For those with near-term needs, the stock market might not be the best avenue. For those with longer horizons, time is on your side. Investing over longer periods is the way to go.
To illustrate this point, John Riddle, Managing Member & CIO of Jackson Creek constructed a model to evaluate various investment scenarios. He created different potential options for investing an annual sum. There are two hypothetical scenarios that are unattainable, but useful for educational purposes, and five real world options. For simplicity, the the entire amount is invested in the S&P 500 index. With this lump sum to invest each year, we look at various entry points. All deposits occur at the end of the month (i.e., investing in January means January 31st). A “high” or “low” refers to year-to-date returns as of the end of each month.
The strategies are:
"Lowest Month” - Invest when the market is lowest during the calendar year. This is being able to time the market bottom every year.
“Highest Month” - This is the opposite of Lowest Month. It would mean investing at the market peak each year.
“Beginning of Year” - Investing in January each year. This is the longest time in the market.
“End of Year” – Waiting until December each year. This is the shortest time in the market.
“Mid-Year” - Investing on June 30th each year. Split the difference between Beginning and End of Year.
“DCA” - Dollar cost average. Split the sum evenly across each month. A $10,000 annual investment translates to $833 each month
“Random” - the model chooses a random month each year to invest the sum.
Options 1 & 2 are the unattainable hypothetical scenarios that create goalposts for the exercise. It probably comes as no surprise that of all the seven options, investing at the lowest point (#1) each year provides the best outcome, while investing at the high point (#2) results in the worst performance. Everything else falls in between.
Among the real-world scenarios (options 3-7), Beginning of Year is the best option and End of Year is the worst. This should not be a surprise by now. It allows for the greatest amount of compounding and removes the futile guesswork of identifying an optimal time every year.
This exercise revealed other useful information. First, the differences between the options are not that extreme. As the investment horizon increases, the return differences between each option decreases. Anyone who had the good fortune to live for over 151 years (1871 – Sept. 2022) and save $10,000/year would have seen their investment grow to $85.3 billion using the Beginning of Year strategy but would still have $81.4 billion using the End of Year strategy - only a 4.7% difference.
In a more realistic situation, someone saving $10k/yr. for the last 40+ years (1982 – 9/2022) would have amassed $5.72 million with the Beginning of Year approach. This compares to $5.92 million for being able to perfectly time the market low each year since 1982.
Ending wealth of $10,000 annual investment, 1982 - Sept 2022
Source: Jackson Creek Investment Advisors, S&P Global; all returns are for illustrative purposes and not meant to be indicative of any expected returns. See full disclosure on main blog page.
The other interesting insight is the Mid Year, DCA, and Random strategies were very similar to each other.
The Random approach fluctuates above and below Mid-Year & DCA but also quite similar. Mid-Year slightly edges out the DCA approach over the 1982-9/22 period. The Random outcome fluctuates between being the best and the worst. Over this period the Mid-Year strategy ended with $5.38 million, the DCA with $5.35 million, and Random with $5.34. Each are below the Beginning of Year, but not enough to make a significant difference in ending wealth. Saving and time are key determinants of building wealth. Market timing – not so much.
The Random option is interesting, too, in that it is still a realistic example. We do not always get cash to invest at regular intervals. Bonuses, commissions, asset sales, inheritances, etc., can come at various times. The point still remains. Timing is difficult at best
The bottom line is that investing right away versus trying to time the optimal entry point is the best strategy for long-term holding periods.
Time is on your side. Cue the Rolling Stones, or the original version by Kai Winding, or this one by Irma Thomas.